The Twelve Rules of Investing, Rule #11: Don’t trade on the basis of widely-known information

Posted on Posted in Financial Blog

Information that is widely known—and this basically means all information you can legally obtain—is already reflected in stock prices by the time it reaches you. This means that news you hear on CNBC or read in the Wall Street Journal is useless for making short-term investment decisions. (This doesn’t mean that all information is worthless, just that it’s of no help in deciding when to buy a stock.)

A perfect example of this is the recent turnover of control in Congress from Republicans to Democrats. Certain industry groups likely to be affected by this power shift moved sharply during election week as the House and then the Senate fell into Democratic hands. Drug stocks, for example, dropped over -5% in 2 days. If you sold these stocks after the election results were in, they were already at their short-term lows and recovered a good part of their losses over the few days. Only if you were clairvoyant and knew ahead of time that the Democrats would win the Senate could you have made any money on this. Whatever drug stocks do from here will no longer depend on this information.

The way to use information to earn superior returns in stocks is either to know something no one else does (unlikely), or to interpret the information differently and correctly compared with the crowd. The latter is possible with experience and effort, but very difficult to do.